In more than 2 years since the "DeFi Summer" broke out in 2020, many extremely successful DeFi projects such as Uniswap, AAVE, Yearn Finance, and DAO Maker have emerged, and Total.Value Lock (TVL of DeFi projects) in 2021 Reached over $250 billion in ATH. However, this model encounters difficulties with scalability, security, centralization, liquidity, and scalability. Access to information……
Therefore, many people are currently looking forward to the development of a DeFi trend to improve these things and improve user experience, and it is called DeFi 2.0. So what is DeFi 2.0? How important is DeFi 2.0? Is this the future of decentralized finance? Let’s learn more through my article!
DeFi 1.0 – Early Development
DeFi (Decentralized Finance) is a form of finance based on blockchain that differs from traditional financial services in that DeFi does not require any intermediaries to execute transactions. Blockchain technology in DeFi eliminates banks and other intermediaries including brokers, exchanges, etc.
The first pioneering projects of DeFi include some prominent projects such as Aave, Compound, MakerDAO, and Uniswap… These first projects laid the foundation for the strong development of DeFi.
Aave and Compound offer decentralized lending capabilities that allow for on-chain returns on deposits. In 2021, Aave and Compund reached TVL of over $19 billion and over $12 billion in ATH levels, respectively.
MakerDAO provides projects in the ecosystem with a decentralized stablecoin for trading, providing investors with confidence against cryptocurrency volatility. The peak of MakerDAO’s development was in 2021, when the project’s TVL reached over $19 billion in ATH.
Uniswap offers a decentralized exchange where traders can exchange tokens without having to fill out cumbersome KYC and AML documents…
What is DeFi 2.0?
DeFi 2.0 is a phrase in the blockchain world that refers to a set of DeFi projects that build on previous DeFi breakthroughs (or commonly referred to as DeFi 1.0), such as yield farming, lending... to upgrade and overcome the limitations of DeFi 1.0 limitation.
DeFi 2.0 focuses on improving the existing liquidity, scalability, governance, and security issues of DeFi 1.0.
Limitations of DeFi 1.0
Before we dive into DeFi 2.0, let’s take a look at the limitations of DeFi 1.0:
Scalability - Scalability: Expensive transaction costs; slow transaction speeds lead to long waiting times, which greatly affects the user experience. As shown in the figure below, the TVL of dApps on Ethereum currently still accounts for a large proportion, close to 65%. Most DeFi solutions are built on the Ethereum blockchain. Due to the large number of users on the network, there is a significant Delays and soaring transaction costs are understandable.
Liquidity: Liquidity is considered the lifeblood of any trading market, and with DeFi, liquidity is often low and underutilized.
Centralization: Currently, many powerful projects still belong to a small group, usually a development team or a large shark.
Security: Many users do not manage or understand the potential risks in DeFi. They pour millions of dollars into smart contracts without fully knowing whether it is secure or not. Over the past year, we’ve seen a continuum of hacks from large platforms to small platforms resulting in hundreds of millions of dollars in losses. Therefore, the security of the project is not given much attention.
Oracle attacks: DeFi relies heavily on Oracles to obtain external information, but many projects do not integrate or choose a side that is not good enough. As a result, the project suffered attacks such as flash loans.
Capital Efficiency: There is currently a large amount of assets locked in protocols that remain underutilized, which opens up a lot of future growth potential for DeFi.
Why is DeFi 2.0 important?
Even for experienced crypto users, DeFi can still be very confusing. However, the purpose of DeFi is to lower barriers to entry and create new earning opportunities for cryptocurrency holders. Users may not be able to get loans from traditional banks, but they can through DeFi.
DeFi 2.0 is important because it democratizes finance without introducing risk. DeFi 2.0 attempts to solve the problems mentioned in the previous section and improve user experience. If DeFi 2.0 can do this and provide better incentives, all users of the crypto market will benefit.
One risk point often mentioned in DeFi 1.0 platforms is that no one in DeFi 1.0 is responsible for security breaches, so there is almost no chance of tracking down who stole it and recovering the lost money. Several vulnerabilities in previously developed contracts cost owners millions of dollars, and DeFi 2.0 is a long-awaited improvement to these vulnerabilities.
Advantages of DeFi 2.0
Smart Contract Insurance
While DeFi runs on open source and transparent infrastructure, conducting due diligence and risk analysis on the protocol can be difficult for newcomers. DeFi 2.0 alleviates this difficulty by providing users with smart contract insurance. In the past, when users staked their LP tokens into yield farming, previous profits were at risk because they could lose all their tokens if the smart contract was compromised.
While DeFi runs on open source and transparent infrastructure, conducting due diligence and risk analysis on the protocol can be difficult for newcomers. DeFi 2.0 alleviates this difficulty by providing users with smart contract insurance. In the past, when users staked their LP tokens into yield farming, previous profits were at risk because they could lose all their tokens if the smart contract was compromised.
Many people like staking LP tokens in smart contracts but are concerned that the contracts may be compromised. With DeFi 2.0, insurance projects can guarantee deposits through fee farms. Despite improvements in risk exposure, the overall details of these insurance platforms are far from perfect and are highly dependent on specific smart contracts.
self-pay loan
Typically, borrowers face liquidation risk and high repayment interest rates. DeFi 2.0 helps overcome these pitfalls by offering self-pay loans. In a self-pay loan structure, the lender can repay the loan using interest earned on deposited collateral.
The deposited collateral is returned to the borrower after the lender earns the total loan amount plus insurance premiums. There is also no liquidation risk with self-pay loans. If the price of the collateral token drops, the time it takes to repay the loan will be lengthened accordingly.
permanent loss insurance
Normally, for users who invest in liquidity pools and engage in liquidity mining, any change in the price ratio of the two locked coins may lead to losses for the users.
This phenomenon is known as impermanent loss, and it is one of the saddest characteristics of decentralized finance.
DeFi 2.0 projects are introducing new measures to reduce this risk. Some protocols use fee proceeds to insure users against such losses. They can also mint new tokens to cover their losses. All these policies make DeFi a safer option for cryptocurrency investors.
Risks of DeFi 2.0
Despite major improvements, DeFi 2.0 still carries several risks, including:
Attacks from hackers
We cannot be completely sure that the smart contracts we are interacting with are not vulnerable to hackers. Auditing has never been a reliable way to ensure the security of smart contracts. Therefore, before participating in a DeFi project, it is most important for us to conduct research and evaluation of the project.
market fluctuations
Decentralized finance is only possible using cryptocurrencies, many of which are highly volatile. When prices move wildly, investors face consequences. Some protocols mitigate this risk by providing users with stablecoins for transactions. Likewise, the inherent volatility of cryptocurrency markets will always be a factor affecting decentralized finance.
Tightening of regulations
As governments and regulators become more interested in DeFi, projects and platforms may need to adjust rules and services to comply with industry standards. While it can help provide greater stability and security, it also changes the level of support and affects decentralization.
Summary:
DeFi 2.0 is considered an improvement on DeFi 1.0, but whether DeFi 2.0 is really better than DeFi 1.0, we will need time to answer. I hope that through my article, I can help you have more views on DeFi 2.0 and get more useful information during the investment process. Don’t forget to continue to pay attention to subsequent articles, please!
